Netflix stock hammered as subscriptions fall

EARNINGS Subscriptions drop; stock hammered

Published 4:00 am, Tuesday, October 25, 2011

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SAN FRANCISCO - FILE: Red Netflix envelopes sit in a bin of mail at the U.S. Post Office sort center March 30, 2010 in San Francisco, California. It was reported that at the closing bell today Netflix will release its third quarter financial performance report in addition to it's announcement that it will be expanding business to Great Britain and Ireland october 24, 2011. (Photo by Justin Sullivan/Getty Images)
Ran on: 10-25-2011
The number of Netflix customers with mail subscriptions is dwindling the company may lose millions this quarter. less

SAN FRANCISCO - FILE: Red Netflix envelopes sit in a bin of mail at the U.S. Post Office sort center March 30, 2010 in San Francisco, California. It was reported that at the closing bell today Netflix will ... more

Photo: Justin Sullivan, Getty Images

Netflix stock hammered as subscriptions fall

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Netflix posted a healthy profit gain Monday, but the company's already ailing stock price was massacred in after hours trading as investors reacted to a greater than expected exodus of subscribers and a forecast for red ink in 2012.

In total, Netflix lost 805,000 subscribers for the quarter, about 200,000 more than the company estimated last month, after executives fumbled a price increase and a branding change.

Within minutes of the quarterly earnings report's release, the company's stock price fell through the floor and dropped about 27 percent, from $118.84 to $85.75 per share in after-hours trading. Netflix had already lost nearly $9 billion in market value since the start of the third quarter in July, when its stock hit an all-time high of $304.79 per share.

Earnings for the quarter were actually up. The Los Gatos company posted third quarter net income of $62.5 million ($1.19 per share) compared with $37.9 million (73 cents) for the same quarter a year ago. Revenue was nearly $822 million for the quarter, about 49 percent more than the same quarter last year.

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Streaming in Britain

And earlier in the day the company delivered some encouraging news to investors by announcing plans to expand its Internet streaming service to the United Kingdom and Ireland in early 2012. Netflix now offers streaming of movies and TV shows to 43 countries, including Canada and countries in Latin America and the Caribbean.

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But equity research analyst Michael Pachter of Wedbush Securities said the company's earnings report yielded another surprise change in strategy - Netflix is not going to be able to finance its international growth through its domestic profit as previously planned.

In fact, Netflix forecast more subscriber cancellations and said it will have to pause its international growth because the expansion of streaming into Britain and Ireland will push the company into unprofitability overall for "a few quarters," starting with the first quarter of 2012.

"A few quarters usually means three or more quarters," Pachter said. "Are they going to even make a profit next year? People like consistency and this company has gone from extraordinarily consistent to completely inconsistent and that's why the stock is down."

In a conference call with analysts and in a letter to shareholders, Chief Executive Officer Reed Hastings acknowledged that the last few months have "been an extremely challenging time to be a shareholder" as the company's reputation took a hit.

In July, the company announced a pricing structure change that meant some customers who paid for both the DVD-by-mail and Internet video streaming services would have to pay up to 60 percent more per month to keep both.

The announcement generated a tidal wave of subscriber cancellations that lasted through September and October "as people became more aware of the price increase," Hastings told analysts.

Hastings has apologized for not properly explaining the price changes, but last month opened a new Pandora's box by announcing Netflix was splitting the DVD service into a new unit, with a separate billing system and website under the new name Qwikster.

Three weeks later, the customer furor was so intense Hastings was forced to backtrack and kill the Qwikster idea.

In theory, the two brands made sense, but "in practice, Qwikster became the symbol of Netflix not listening," Hastings said. Netflix ended the quarter with 23.8 million U.S. subscribers, down from 24.6 million in June. The company originally forecast 25 million by the end of the quarter.

Projected growth

Most of the projected growth remains on the Internet streaming side. The company projects the number of DVD subscribers to plunge from 13.9 million to about 10 million by the end of this year.

In the letter to shareholders, Hastings and Chief Financial Officer David Wells said the company's "long-term streaming opportunity is as compelling as ever and we are moving forward as quickly as we can to repair our reputation and return to growth."

Netflix isn't planning to raise rates any further, but still isn't planning to offer a discount to lure back subscribers who may have canceled. The company believes DVD-by-mail customers will diminish over the next decade.

"In the U.S., we'll build back our brand the same way we built it in the first place: no grand gestures, just amazing service day-after-day, for an incredibly low price," Hastings wrote.

Still, the company's missteps will have investors questioning its strategy. Pachter believes the stock price will drop even further.

"I honestly think they kind of lost it for a few months," he said. "The price increase was not well thought out. Clearly, Qwikster was not well thought out."